Monday, July 18, 2016

Should You Form a Writing Business?

Hi Folks,

Travis here again! Back in my popular Your Author Brand post, I mentioned talking about businesses, as in, should you form a company as a writer? Judging by the comments, this is a very widely desired topic, so that's what we're going to talk about today. I'm sorry it took so long, but this is a massive topic and I had to do a lot of research.

I'm sure ya'll always hear that you should treat your writing like a business. This time I'm going to talk about the literal version of that statement - making your writing into a formal company.

Disclaimer #1 - Because we live in America, this is intensely USA oriented information. I'm sorry if you're looking for business advice in another country.

Disclaimer #2 - I am not your legal counsel nor your qualified accountant. We do not have a client relationship. I'm telling you what I've found and heard so that you can go look into more and proper details. Don't tell the IRS "but Travis said so!" because they won't care. If you want to do anything I've talked about here, go sort it out with an actual accountant or lawyer!

Now that's out of the way...

Should You Form a Writing Business?

The title is a question, and rightfully so. This is not a black and white choice. There are many benefits to starting a company, but there's a lot of drawbacks, too. Success as a writer is not dependent upon creating a fancy business. There are decades of successful writers who never formally created a company for writing. Honestly, this very question is relatively new on the scene thanks to the self-pub revolution.

So should you start a business? Well, that depends on a lot of factors, and the one we're going to start with is income. There are three types of author income, and which kind you make will completely change the landscape of whether or not forming a business is right for you.

Turns out, if your writing is a hobby, there's some unusual tax deductions you can claim. For example, if you lost money on a novel, that loss can be claimed against your normal income. You can also deduct expenses against the hobby income kinda like you can for a business. There's more than I can list here, but here's a good start.

If you're just starting out and not making a lot off your books yet (or if you have yet to make money at all), claiming your writing as a hobby can be a huge savings. Unfortunately, while I'm sure all of ya'll's ears just picked up, by reading a post like this you are on course for not being able to claim hobby income.

While the government wants to cut hobbiests a break on their expenses, they completely understand how these rules could be exploited, and so, in classic tax law fashion, there are many many hoops to jump through before those sweet savings can be yours.

Whether or not you can claim your writing income as hobby income depends on your ability to navigate the following criteria:

Whether you carry on the activity in a businesslike manner.

Whether the time and effort you put into the activity indicate you intend to make it profitable.

Whether you depend on income from the activity for your livelihood.

Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).

Whether you change your methods of operation in an attempt to improve profitability.

Whether you or your advisers have the knowledge needed to carry on the activity as a successful business.

Whether you were successful in making a profit in similar activities in the past.

Whether the activity makes a profit in some years and how much profit it makes.

Whether you can expect to make a future profit from the appreciation of the assets used in the activity.

Basically, if you treat your writing as something you do purely for fun as a hobby (ie, not trying to improve profits), you're cool. But if you're actively making changes and improvements to make more money, then you're acting like a business professional, and you're not a hobby writer.

It's your classic tax Catch-22. If you're professional enough to want to save on your taxes by claiming hobby income, then you're probably acting like a business and can't claim it.

(╯°□°)╯︵ ┻━┻

This doesn't mean hobby income is completely off the table. If you're adamant that your writing is a hobby (ie, you just want to write and be read and don't really care if you make a dime, but you also don't want to be overcharged on taxes for income you do make), then go look at how hobby income works tax-wise. But if your goal is to go pro one day, then you're already a professional by tax accounting standards (yay?) and are probably better off classifying any writing income you receive under our next category...

Writing Income Type 2: Self-Employment Income

Most writers, new and established, let their royalty checks come in as self-employment income. This is the default mode if you do nothing special in regards to business structure. It's the easiest by far because all you have to do is get the check, cash the check, and then report the income. Unfortunately (like most easy things), it's also the most inefficient and expensive way to receive writing money when it comes to taxes.

If you have a book for sale, and you're depositing your Amazon income or publisher checks into your personal account like you would a paycheck from your day job, then it's going to be treated, and taxed, worse than all your other income.

First off, writing money has no withholding. Unlike your employer, Amazon/your publisher is not keeping back a portion of your money to pay the IRS for social security and so forth come tax day. So you have to do this manually as a self-employed individual. This can be seriously troublesome if you aren't good at saving money.

Secondly, employers pay part of the self-employment taxes on your behalf. But, when you sell your book, whether you sell it to a publisher or directly to the public yourself, there is no employer, which means you get hit by the full ~15.5% of the self-employment taxes. This is about ~7.3% more than you pay on the same income at a normal job, where the employer pays the other half of these taxes on your behalf via the payroll tax mentioned above.

As your personal income climbs, so to does your exposure to the higher brackets. Add in the increased SE tax burden and manual withholding, and you'll start to see how hairy tax day can get. There's a reason taxes are a year-round concern for me.

(By the way, in trying to explain this to other authors, I've found that most people don't actually understand how USA tax brackets work. To be fair, it doesn't work like you'd think it should at all. So if you're at all foggy about how tax brackets actually work, here's a good explanation that all US citizens should know. If you want to hip-shot your tax exposure, see this handy calculator. Author, improve thy financial literacy! ^_^)

So as we've seen so far, treating your writing money as self-employment income is the easiest but most expensive way to go about things. Again, if you're not making a good share of your money off your books, 7.3% is not a big deal nor is the withholding. But if writing is a significant income for you (or you think it will be soon) then you'll want a stronger tax strategy for the future.

Writing Income Type 3: Business Profits
While marking down self-employment income on your taxes technically makes you into a business (a sole proprietorship, specifically), it doesn't actually afford any real benefits beyond the ability to deduct business expenses. It also doesn't really change the nature of your income. To do that, you have to form a business and form one of the right type in the right way. (covered in next week's post)

Not to poo poo the deductive power of expenses though! Business expenses can save you a lot on your taxes and learning how to properly claim business expenses is a good first step towards forming a full company. There's no reason for you to not get started on this right now.

As a side note, authors in particular have a fun tax deduction: research! Whatever you're writing a book about, you can probably find a way to go on a research trip and deduct it. I've heard of authors deducting sky diving lessons, vacations to exotic locations, race track time, and more all because those things featured in their novels at some point.

(Hey Rachel, set the next Heartstrikers book in Hawaii ok? I have several key tourist locations for fights to happen at as well. It's research!)

The implicit sole proprietorship is a nicety, but it doesn't explicitly make you into a business in a restrictive, binding sense. That's important because this means you aren't limited in your options to form a real, legit, formal business later should you choose to do so. (Not all types can convert to all other types once formed)

So, that covers the basic three options for your writing income! Honestly, you can get by pretty well for a long time with just the first two, especially if you are ruthlessly diligent about finding and using all available tax deductions and credits! (and business expenses)

So now that the basics are out of the way, let's move on to the real wizardry of this post: should you form a formal business around your writing?

The Pros of Having a Company

Before getting into the specific types of companies you can form, how they work, and how much time and money each one will cost you let's talk broadly about the benefits that having a formal company will afford you.

Benefit #1: Easing the Tax Woes

This is the biggest one for authors. All those problems I mentioned, well, they get easier when you have a real business. Take withholding for example. Some company setups (like an S-Corp) let you pay a salary, which means your company can manage the withholding that goes with the salary.

Once you have a salary set, you can pre-calculate the withholding. From there its just a matter of making sure you have the money needed for both as you go. Trust me, this is easier than high jumping once-a-year hurdle. It does require good money management skills however, but nothing will save you from needing those.

There's also, of course, business expenses, but I've beaten the expenses horse enough for now.

More importantly, some forms of business (specifically S-Corps) can reduce your exposure to self-employment taxes. This is hard and tricky to accomplish and we'll talk more about it in part 2 of this post next week.

My money, now.

How much can these kinds of savings make? Well, I saved us $10k last year thanks to forming our company. That's not chicken scratch, and this year I suspect the number will be even higher. Using all the tools available to us reduces lost opportunities and makes it easier to pay what the law says is our fair share.

(Not that we mind paying taxes, btw! Both Rachel and I love the roads and schools and safe food that the government provides. We just don't like paying more taxes than we're legally obligated to pay ^__^. Its sadly harder to accomplish than it should be)

Anyway, the point here is that your ability to handle and reduce your tax burden goes up when you form a company. How much mileage you get from this personally, though, will vary with the type of company you choose to form as well as your personal financial situation.

Benefit #2: Liability Protection
Forming a business isn't all about money, though. Putting yourself behind a company (like an LLC) can also protect you and your personal assets (your house, car, savings, and so forth) from being pillaged by losing a lawsuit or by debt collection.

Not all business types offer good or any liability protection. For example, the sole proprietorship we talked about when we first mentioned listing your writing money as business income has practically zero liability protection. Limited Liability Corporations, or LLCs, on the other hand have tons. (Note though that liability protection only refers to liabilities incurred by the business or directed at the business. It can't save you from personal lawsuits.)

Thankfully, authors usually don't have to worry too much about this. You deal with the public in a way that's insulated by the book distributors like publishing houses or Amazon itself. Still, getting sued isn't impossible, and the bigger you grow, the more this might be important. Most super famous authors have had to deal with at least a "you stole my idea" type of lawsuit at some point. When that happens, it's nice to have some protection, and if you can get it while also getting many other sweet benefits, so much the better!

Benefit #3: Easier Accounting

This isn't a problem for first time authors, but as you grow and consume more author services, tracking all the expenses and revenues becomes increasingly complicated. This is were companies shine. Setting up a formal company also means setting up company accounts that are completely separate from your personal money. It's wonderful to have a dedicated set of credit cards, checks, and account books just for the company. We have a relatively simple income stream for an author who's been writing for ten years, and being a company still saved me five days of tax work last year!

It all comes down to organization. I used to have to spend tons of my time teasing out every single business related expense from the thousands of yearly personal transactions in our joint accounts. Now, so long as I use the company cards and checks whenever I make a business purchase, I just have to make sure that all transactions are properly filed in Quickbooks and the accountant does the rest. It's wonderful! Also way more accurate as I don't miss anything at all.

A side bonus is that most accounting programs, like Quickbooks, will also come with oodles of reports that you can just click to get. Wanna see profit-loss for the year? Already done, son! This is increasingly vital stuff as your career and income streams grow. People who don't keep an eye on their business metrics are just flying blind.

Benefit #4: Becoming a Legal Entity

Last but not least, being a business comes with a lot of built in legal niceties. Being able to umbrella contracts, payments, hiring, and other weighty legal actions under a discrete business entity rather than as an individual is incredibly advantageous. It separates you and your personal life from your company to some extent.

The mileage on this varies widely with the business type, so I'm not going to say much more here. Rest assured, though, the first time you have a contract go south (and if you keep writing, it will almost certainly happen at some point in your career. Something will go wrong someday, I guarantee it), you will be damn happy to be dealing with that mess with a company between you rather than having to be knee deep in the fallout personally.

Intangibles

So those are all reasons why having a company is awesome, but there's more to it than just what you see above. It's hard to explain, but after having a company for a year now, I can definitely say that just having a company puts you sort of into another sphere. If you have an actual company--not just an implicit sole proprietorship--then you can act like a company and be treated like a company by other business.

For me personally, I have a salary and a job title again. This is a huge improvement from my previous, ambiguous as hell situation. It used to be people would ask, "What do you do?" and I'd reply with something fishy and insecure like, "I'm unemployed technically and I'm partly a house husband, but really I'm Rachel's publishing assistant, financial manager, marketing manager, editor.. blah blah...justifications for my worth as a human, don't think I'm a loser please." Nowadays, though, I say, "I'm the general manager of Aaron Bach LLC." If they ask what that is, then I have a list of impressive sounding duties that have legitimacy 'cause I'm running a company.

So yeah, the trappings of business have their advantages in and of themselves. Sometimes they're obvious, like getting business level service at banks. Othertimes they're more nebulous, like getting a cool title on your business card. (Also, having a business card!)

Ultimately, the bottom line is that having a company makes you act like a business, and that's generally pretty good for you and your career, especially in an artsy, often looked down upon profession like writing. Forming an actual business is the ultimate expression of our old "treat writing as a business" attitude. It's the difference between acting and being, and it's been very good for us as a whole.

But while we clearly love being a business and benefit from it hugely, owning a business is not without its drawbacks.

The Cons (or Con, really) of Having a Business

Up until this point, I've told you all the reasons having a business is awesome. But while all of that is true, there is one major drawback, and that drawback is overhead.

Overhead refers to the time, money it takes to form and run a business. How much overhead you have depends on the type of company you choose to form, but there's no escaping the fact that it takes resources--money, time, the effort to educate yourself, finding and paying experts to help you with the stuff you can't do on your own, paying government fees, etc.-- to setup a business. Also, whatever company you form will cost additional resources each year both in terms of money spent paying people like accountants and so fort and in your own time doing the administrative activities all businesses require to stay legit and up to code.

Businesses cost time and money, yo!

Like I said at the top, some business types cost more overhead to setup and maintain than others. A sole proprietorship or partnership is pretty low both in terms of cost and annoyance. An LLC with S-Corp tax election, which is what we chose, takes more time and is more expensive, and a C-Corp is ridiculous!

You'll notice I mention time a lot. This is because all types of companies, even simple ones, come with legal filings, accounts, setup, bankers, and more just as part and parcel. None of these are necessarily hard or time intensive alone, but when you lump them all up together, they really add up. Since Rachel and I are a team, I handle 95% of this overhead since my time is normally hard to monetize in a direct manner. This way, with me taking on all the business overhead, she has more time to focus on writing books.

This division has worked fantastically for us, and you might have picked up from all the pros above, it's been totally worth it! As I said earlier, I saved us $10k last year just with the formation of the company. That savings alone pays for a lot of overhead, but we're kind of a special case.

If you're an author going it alone, it might not be as easy to find the time to do all of this business management stuff. Sure, you're almost certainly going to save money on your taxes, but if the overhead of keeping the business going eats into your writing time so badly that you're not actually writing the books, it doesn't matter how much you save: that's a deal breaker. (If you're not sure how much time matters, see my post on project management for writers to get an idea of how precious writing time can be.)

As you see, overhead is not to be dismissed lightly. Businesses are complicated beasts that have to be treated with caution and respect. It is absolutely possible to totally F-up the founding of your business and get yourself into real legal trouble. You can also get yourself into tax trouble if you don't keep good records. Nothing ruins your year like having the IRS mad at you!

These situations are pretty easy to avoid just by doing your research and then involving the proper professionals to help guide the process of setup and yearly maintenance.

(LLCs for Dummies I would highly recommend! It covers more than LLCs as well). That said, one thing that I've found frustrating is how hard it is to get a straight answer from any expert on the technical details of running our writing business. Authors are just not a business type many accountants have experience with, and it can be tough to find a good one who has experience dealing with the unique financial situations writers face.

In the end, you just have to do a lot of the research yourself. Professionals can help, but if something goes wrong, it's your butt on the line, not theirs. Companies are hugely powerful and can save you a ton of money, but with great power comes great responsibility. Hopefully, this post has made the landscape of author business ownership clearer, but in the end, the question of "should you start a business?" depends on you. Only you can say if the amazing benefits of all those tax savings and legal protections are worth the time and financial overhead of starting a company of your own. But if you're making money off your writing, or if you hope to in the future, then starting a business is definitely worth your serious consideration. Even if you decide not to do it, knowing how a business works is never wasted knowledge!

After all, no one ever said "oh, darn, I know too much about business." ^_^

Wow, this post has gone on way too long!

That's probably enough technical finance for one Monday!

oro oro oro oro...

I'll be back next week to talk about all the different kinds of business you can form. There are a lot of options, all with their own pros and cons for the working writer. Thank you for reading, and I hope I've gotten you interested in the powerhouse fortress that is a well run writing business!

If you like my business stuff, please follow Rachel on social media (Twitter/Facebook/Tumblr/Google+) to get live updates for each new post! You can also follow me on my own account @TravBach for general publishing nerdom. Thank you so much for reading, and be sure to check out Rachel's writing post this Wednesday!

4 comments:

Wow, quite a lot to digest here, though I would disagree that it ran too long. Even though I went through it three times, the second two times slowly, I would have been happy to read a lot more.

I’ve been thinking about this for a long time. I sell used books on the internet and am writing a series of travel books soon to hit Amazon, and I need more than the Excel spreadsheet I’ve used so far. (I used to write SF/F/Mystery short stories, still love to read them.)

The timing seems right so I ordered the LLC book from Amazon (the article linked to an older edition, btw; ditto the Lynley link), checked out Quickbooks online, picked up a pair of Quickbook manuals from B&N, and today talked to the bank about business checking accounts. Busy two days with a total of zero words written but a lot to think about.

I really appreciate the job you did on this article and am looking forward to the next one. (Especially interested in LLC filing as S Corp, and shares. Shares?)

Thanks Tom! This thing too a lot of work, so I'm glad that its being useful. Also, I've fixed the links. Thanks for the heads up.

Real quick, S-Corps have stocks and shareholders. Unlike C-Corps though, S-Corps only have 1 type of stock and can only have up to 100 shareholders regardless of how many shares there are or how they are split up.

Depending on how the S-Corp is setup (I believe they have operation agreements like LLCs), shareholders may or may not have a hand in running the business. Mostly, the shares are used to determine ownership % and the division of distribution of profits.

For example, if someone owns 5% of the business, an investor perhaps, they may be a member but not a manager. When the business distributes profits though, that person gets 5% of the distribution every time.

I'll talk more about this next week though. Haha, I don't want to put it all in the comments ^_~

Very useful, Travis, and in reality more than that--it was a catalyst in the sense it got me to get beyond goggling, planning, and more googling. And looking to see what names and domains were available.

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Who are you again?

My name is Rachel Aaron/Rachel Bach, and I write the books you see over there on the left. I also play video games, watch anime, read manga, and read a TON of books. I love great sword fights, witty dialog, and charming rogues (except for the ones who stunlock me).